China is paving a better road ahead for its electric-car industry. Its car makers could be in for a rough ride meantime.

Beijing said Tuesday it will cut subsidies for electric-vehicle purchases by at least 65%, following a three-month transition period. The cut wasn’t a surprise, but its magnitude was—analysts had been expecting a subsidy decrease of about 40% to 50%.

The Chinese government will also impose tighter standards on auto makers. EVs will only be eligible for a subsidy if they have a battery range above 250 kilometers (about 155 miles), while the subsidy quantum will depend on inputs such as battery density or energy consumption. Shares of major Chinese EV makers fell after the news: BYD fell 2.4% while
NIO Inc.
dropped 7%.

Beijing’s larger-than-expected cut is mostly in line with its plan to phase out EV subsidies, especially for less-efficient cars. Instead, it is launching a credit system designed to encourage auto makers to make more and better EVs. Each company will earn credits based on criteria such as the proportion of cars it produces that are electric. Those whose cars fail to meet basic standards, in areas such as fuel efficiency, will have to purchase credits from other car makers or face penalties—a system akin to carbon credit trading. The new industry model should help weed out weaker players and spur consolidation.

Rather than spending on subsidies, Beijing also plans to encourage local governments to spend more on EV infrastructure, such as battery-charging stations. Such top-down policies will inevitably create some waste. But better infrastructure is precisely what is needed in China to make owning an electric car more desirable. Many Chinese people live in dense urban areas, meaning the country could need about 14 million public charging stations by 2030, McKinsey estimates.

The message is clear: Beijing is serious about creating an environment that will encourage the electric car industry to grow. Picking winners in the sector remains tricky—NIO’s shares have plunged in recent weeks following its warning of a dismal first quarter. Still, Beijing’s latest measures should reassure investors about the industry’s long-term outlook, even if slashed subsidies deflate some companies’ tires for a little while.